Market uncertainty over the future of the euro has returned, but that hasn't stopped France from flouting European Union deficit rules. Berlin is already busy hashing out a dubious compromise.

Following three hours of questioning at European Parliament, a visibly exhausted Pierre Moscovici switched to German in a final effort to assuage skepticism from certain members of European Parliament. "As commisioner, I will fully respect the pact," he said.Moscovici was French finance minister from 2012 until this April and will become European commissioner for economic and financial affairs when the new Commission takes office next month. But can he be taken at his word? There is room for doubt.In response to the unprecedented euro-zone debt crisis, the European Union agreed to strengthen its Stability and Growth Pact in recent years. Member states gave the European Commission in Brussels greater leeway to monitor national budgets and also bestowed it with rights to levy stiffer fines for countries that violate those rules. Smaller member states have already been forced to comply. Still, as German Chancellor Angela Merkel herself has told confidants, the real test will come when a major member state is forced to submit to the EU corset. That time is now. And the big EU member state in question is France. The development is creating a dilemma for Merkel.

Market Jitters

The issue is far greater than a few tenths of a percentage point in the French budget deficit. At stake are France's national pride and sovereignty -- and the question as to whether the lessons of the crisis can actually be applied in practice. Also at stake is the euro-zone's trustworthiness, and whether member states will once again fritter away global faith in the common currency by not abiding by their own internal rules. "The markets are watching us," says one member of the German government -- and he doesn't sound particularly confident that the world will be impressed. The markets are indeed jittery. The German economy is growing more sluggishly than expected and is no longer strong enough to buoy the rest of the euro zone. Interest rates for Greek government bonds have suddenly surged, likely because of domestic political instability, rising close to the levels that threatened to push the country into bankruptcy in early 2010. Meanwhile, the European Central Bank has already used up a good deal of the instruments it might have used to combat a new crisis. Euro fears are returning, certainly not a good time to sow additional seeds of doubt. But if experts in Brussels are right, France is doing exactly that with its 2015 draft budget, submitted last week. It suggests that the French government is on the verge of delivering even less than the already low expectations of the European Commission. One high-ranking EU diplomat scoffed at the 60-page draft budget, saying it gave the impression that it had been written mostly by "poets and alchemists." The document itself speaks of "substantial efforts since 2012" and "unprecedented fiscal consolidation measures."

Paris Wants to Increase Debt

The tone doesn't become more subdued until near the end. Instead of reducing borrowing in 2015 to the 3 percent of gross domestic product (GDP) permitted under the pact, Paris is now planning deficit spending of 4.3 percent. The country doesn't plan to bring itself back in line with Stability Pact rules until 2017. In addition, the sovereign debt ratio is to rise from 92.2 percent of GDP in 2013 to 97.2 percent next year. The numbers look markedly better in many other euro-zone countries, with deficits largely under control. That includes the majority of the crisis countries, which have subjected themselves to tight austerity and reform programs since 2010 in exchange for bailout loans. Against that background, the draft budget from Paris struck many officials at the Brussels headquarters of the Commission's Directorate General for Economic and Financial Affairs (ECFIN) as being particularly brazen. But what can they do? And how can they command respect?Under the provisions of the tightened rules, the European Commission has until Oct. 29 to either approve or reject the budget. Outgoing European Commissioner for Economic and Monetary Affairs Jyrki Katainen, a Finnish hardliner on budget policy, appears determined to enforce the Stability Pact rules. Although he is moving to a new post, he will still have similar responsibilities when he takes his position as vice president of the incoming European Commission.Some smaller euro-zone countries have already felt the brunt of the new pressure coming from Brussels, including Belgium. In December 2011, the European Commission threatened to levy fines against the country if it didn't present a 2012 budget conforming to the Growth and Stability Pact's rules. "They would have had to pay an €800 to €900 million fine," Olli Rehn, the currency commissioner at the time, told EU auditors last week. To avoid the penalty, the Belgian government made cuts to unemployment benefits and raised the age for early retirement.

Are All EU Member States Equal?

But does the euro stability pact truly apply equally to all member states, or are there countries that are more equal than others? That's the "€100,000 question," one German EU diplomat says. Smaller euro-zone nations indicated at the most recent meeting of EU finance ministers that they are unwilling to accept unequal treatment. "In Luxembourg, the principle of adhering to the applicable rules applies to both large and smaller countries. Rules create the stability and security that we need," says Luxembourg Prime Minister Xavier Bettel. However, he adds, the provisions of the stability pact also allow for some flexibility.During his visit to Berlin at the end of September, however, French Prime Minister Manuel Valls took the preventative measure of forbidding any comparisons with smaller countries. "I will not permit people to discuss France in this context," he said tersely during a reception at the French Embassy. "France is a big country." Regardless whether the EU Commission demands more reforms and tougher savings, he said, "We won't do it." Michel Sapin, his current finance minister, upped the ante last week, saying, "we won't cut more anywhere and we also won't raise taxes." He added that the €21 billion in austerity measures already undertaken by France through the end of 2015 were sufficient. Still, even this pledge is on shaky ground. Observers at the High Council for Public Finances, a French public finance watchdog founded in 2012, are critical, arguing that some assumptions in the budget either haven't been proven or are "very unlikely." For example, in the midst of a crisis, there is nothing showing that consumption in private households will increase by 0.7 percent as the budget suggests. In addition, the High Council notes, some of the revenues calculated as part of the draft budget are likely to disappear -- such as the €0.5 billion that will go missing as a result of the French government's mid-October decision to drop plans for a levy on heavy trucks. The European Commission, which has given no indication yet that it has been intimidated by the harsh statements coming from French officials, is likely to have similar reservations. In the coming days, the Commission is expected to call on France to make improvements to the budget. Sources in Brussels say that if Paris doesn't comply, the Commission will reject the French budget on Oct. 29, one of the last days of its current term. "Europe is at a crossroads," says Manfred Weber, the chairman of the conservative European People's Party group in European Parliament, which represents Christian Democrats from across the Continent. "The European Commission's credibility is at stake with its review of the French and also the Italian budgets. France's budget has to be rejected. President Hollande needs to make improvements."Merkel Likely To Avoid Showdown

Still, it's a showdown that Berlin would like to avoid, and Chancellor Angela Merkel is hoping for the support of incoming EU Commission President Jean-Claude Juncker. He will likely to want to sidestep a spat with France at the beginning of his five-year term. The conservative French daily Le Figaro recently wrote that an outright rejection of the budget would have the impact of an "atomic bomb". The signals coming out so far suggest there will ultimately be a compromise, and likely a dubious one at that. Speaking in German parliament on Thursday, Merkel played the part of the disciplinarian. "All, and at this point I will reiterate this again, all member states must fully respect the strengthened rules of the Stability and Growth Pact," she said. The chancellor's words reflected the sentiment of the members of parliament responsible for fiscal and EU policy. "If we make an exception for Paris here, then we are calling into question the entire stability pact," said Gunther Krichbaum, a member of Merkel's conservative Christian Democrats and head of the European Affairs Committee in the Bundestag. "France and Germany have done this before," he said, referring to past violations in 2003 and 2004. "We should not allow it to happen again." Back then, Chancellor Gerhard Schröder and French President Jacques Chirac unceremoniously moved to soften the Stability Pact's criteria because they either could not or would not adhere to its rules. Even today, the move is considered to have been a serious blunder -- one that is often used against Merkel when she calls on other countries to strictly adhere to the rules.

Firm Words, But Little Action

German Finance Minister Wolfgang Schäuble has also had firm words for his French colleagues. "The request for an extension can't seriously mean that nothing gets done," he recently told French Finance Minister Sapin during a meeting. But behind the scenes in Berlin, a much softer tone can be heard. "You just can't do that with France, not with France," one German EU diplomat close to the foreign minister and chancellor said weeks ago. One high-ranking member of Merkel's government says that a formal rejection of France's budget would "massively burden German-French ties." He added: "It would be presented as if we were somehow responsible because of our obsession with austerity." In closed-door talks, Merkel's European policy advisor, Nikolaus Meyer-Landrut, has reportedly assured the French that Germany will oppose any efforts to impose a fine against France if the Commission decides to initiate debt proceedings against Paris. In return for its loyalty, Berlin wants Paris to stick to a detailed timetable for implementing reforms. Some officials in Brussels and Berlin are also pushing to unshelve one of Merkel's pet ideas, so-called "contractual agreements" -- written agreements between the European Commission and a euro-zone country that commit that member state to undertake specific savings measures or clearly delineated structural reforms. Under the original plan, the country could then obtain financial aid from a special fund in return. For France, the reward would be a further suspension of the deficit rules. "We need a calculable and perhaps even an actionable agreement between Brussels and Paris," German government sources say.

Little Progress in Paris

Sending any outward sign of trust to a country that has already been facing proceedings since 2009 for an "excessive deficit" is problematic. The European Commission has already given France two reprieves for getting its public finances in order, but Paris has shown little progress. Neither conservative French President Nicolas Sarkozy nor his Socialist successor François Hollande has managed to get the budget under control. Meanwhile, Prime Minister Valls is facing an open rebellion within the left wing of his party and has only a thin majority in parliament. Nor is it certain that French leaders would accept pressure from the German government to enter into a contract with bureaucrats in Brussels they often view disparagingly. Early this week, French and German economics and finance ministers plan to meet in Berlin. The end of the week will see an EU summit in Brussels.The talks are continuing, but deadline pressures and worries are growing. The issue, says European People's Party parliamentary group head Weber, is not about who is right. "The financial markets have already fired a warning shot at the euro-zone states. A high level of credibility with debt rules is the prerequisite for preventing a new financial crisis." Rehn also has no illusions. "Let me be clear: Reforms in France were not enough to justify the extension," the politician, who is now a member of the European Parliament, said last week. He argues that the reverse should be true. "First, reforms need to be delivered. Then we can talk about an extension." He went on to say that he wishes France's Pierre Moscovici "better success than I had" as an EU commissioner.

MS. GAVIRIA: Good morning. Let me introduce the speakers. In the center, Poul Thomsen, Acting Director of the European Department; to his right, Mahmood Pradhan, who is Deputy Director in the same department; to Poul’ left is Phil Gerson, also Deputy Director; to his left, Aasim Husain, Deputy Director; and finally, Jörg Decressin at the end of the table, also Deputy Director in the European Department. Poul will start with some remarks and then we’ll move to your questions. Poul?MR. THOMSEN: Thank you very much, Angela. Good morning to all of you and thanks for joining us here this morning. Before taking your questions, let me provide some context on developments in Europe, touching on a few key topics.Let me start in the West. Western Europe continues to grow, but second quarter and subsequent high-frequency data suggest that the European economy, especially the euro zone, is facing stronger headwinds than we had expected at the time of our spring meetings here in Washington. For sure by comparison to where we were a few years ago in 2011 and 2012, Europe has certainly turned the corner, but the recovery is weaker than we had hoped for. Domestic demand is recovering too slowly, with some notable exceptions, and external demand has also disappointed.On the positive side, financial market conditions have improved, especially for sovereigns and to a lesser extent for corporates, too. The euro has depreciated in real effective terms. These latter factors should provide an impetus to growth.Taking all of this into account, on balance, what does it mean? We have marked down our forecast and now expect the euro area to grow by 0.8 percent this year, down from 1.2 percent in our spring forecast. Assuming recovery elsewhere in the world as forecast in the World Economic Outlook, we still expect a gradual acceleration of activity in the euro area -- growth of 1.3 percent in 2015 and 1.7 percent in 2016.As to inflation: We project euro area inflation of just 0.5 percent, almost a half percentage point lower than we did in April, and indicators of inflationary expectations have been declining. This, of course, raises worries about the possibility of inflation expectations becoming unanchored and an extended period of very low inflation. This would make it much more difficult for those countries that have to reduce a still excessive public sector debt burden; it would make it much more difficult for households and companies to clean up balance sheets; and it would make it much more difficult for those countries in the euro zone that still have to deal with competitiveness problems. An extended period of high real interest rates is clearly not what Europe needs now.What are the policy implications of the outlook? On monetary policy, we welcome the wide-ranging step by the ECB to counter low inflation and support demand, and its willingness to take further action if needed. As I said, experience has shown that it’s very hard to get out of a situation with low inflation or very low inflation, and attendant low inflationary expectations once they get entrenched.Fiscal policy is in aggregate now only slightly contractionary for euro area countries, striking a much better balance between demand support and debt reduction. In the event of further negative shocks to our revised baseline, automatic stabilizers should in our view be allowed to operate.Structural reforms: The need for structural reforms to boost potential growth and address weaknesses is, of course, well recognized, and the potential for early payoff has been demonstrated by Spain and Ireland, two relatively bright spots in the current situation. Operating on all these fronts is essential. It’s particularly important to persist with strong structural reforms. Beyond the direct benefits of higher potential growth, progress on structural reforms is critical to building and sustaining broad political support for accommodative monetary and fiscal policies in the euro zone. It might be obvious for those looking at the euro zone that there is a demand issue. For those who understand the political economy of Europe, it’s equally obvious that an essential political precondition for Europe’s ability to deal with its demand problem is that structural reforms are pursued vigorously now.Let me turn to the East. We are releasing today our Regional Economic Issues update for Central Eastern and Southeastern Europe. It shows that geopolitical tensions are beginning to take a toll on the region. We have marked down our forecast for growth in 2014 to 1.2 percent from 1.8 percent in April. The largest markdowns have been for Russia and other CIS countries where the effects of Russia-Ukraine tensions and related sanctions are most acutely felt.However, while growth is slowing in much of the region, we are seeing acceleration in Central European countries on the back of stronger domestic demand.What are the risks to the outlook in the East? First, there are two risks that stand out now. First, as mentioned, geopolitical tensions and sanctions are having a marked impact on Russia, Ukraine, other CIS countries and the Baltics. Direct effects elsewhere in Eastern Europe and also in Western Europe have been more limited to date, but there are signs of broader negative effects on confidence that bear very close watching. Further, given the region’s very high reliance on energy imports, any price hikes or lengthy disruption in oil and gas supplies could have potentially serious consequences. Secondly, developments in the euro area are very important for Eastern Europe through low imported inflation, potentially weaker export demand, or lower financing and investment flows. These two risks come on top of the ongoing need to repair private sector balance sheets, bring down high levels of nonperforming loans, and the possibility that a tightening of global financial conditions could lead to market volatility.As to the policy implications, I’ll be very brief. Reducing fiscal and external imbalances as well as enhancing the credibility of policy frameworks will put the region in a much better position to withstand these potential shocks, including from financial market volatility and possible further weakness in Western Europe. Throughout the region there is scope to raise growth prospects and lessen vulnerabilities, whether by tackling NPLs or high private debt burdens, or completing the transition agenda to improve efficiency and transparency.On the latter issues, while the transformation in the region has been astounding in many respects, there’s still much to do; the convergence of incomes with Western Europe was largely put on hold during the global crisis. These countries, thus, still have very significant untapped potential for catch-up gains in productivity. How to unlock this potential will be an important focus of a conference that we’re having in Warsaw in a few weeks, co-hosted with the National Bank of Poland, on the occasion of the 25th anniversary since the fall of the Berlin Wall. I hope that you’re going to join us there.Let me stop here and we’ll be happy to take your questions.QUESTIONER: Two questions, if I may. First of all, how concerned are you about the recent data on Germany? How do you assess the risk of a slowdown? And second, what’s your take on how much more effective the ECB’s ABS plan would be if they managed to secure guarantees from governments on the mezzanine tranches of ABS?MR. THOMSEN: Mahmood, these are both in your area.MR. PRADHAN: Thank you. On your first question on Germany, as you will see from our World Economic Outlook we are quite concerned about the slowdown, particularly for euro area economy as large as Germany. We have revised down our forecast. The negative Q2 numbers have been followed by a number of soft indicators that point to further weakening in Germany, and I think this speaks to Poul’s general point that the euro area recovery looks much weaker than we had anticipated last spring.Your second question was on the mezzanine tranches. It would be more effective if member states were able to provide guarantees on these tranches. It’s not clear to us at this point how this will come out. The discussions as you know are still going on. There may be one or two countries that are willing to put those guarantees in place, but across the euro zone it’s not a decision that most member states have taken yet.QUESTIONER: My question is about the growth forecast for Portugal. It was one of the few I believe in the euro zone where the forecast was trimmed for this year. I would like to know what were the reasons for that, what has been done wrong, and what can be done better? Thank you.MR. THOMSEN: On growth in Portugal, the external environment is somewhat more adverse than when this forecast was made, particularly a slowdown in the contribution to growth from the external sector. I think this points to the need to continue with policies that began under the program, to continue with a reform agenda, and stick to the path of gradual fiscal consolidation. So I don’t think there’s any other policy lesson than to continue what Portugal has done under the program.QUESTIONER: Was there something done wrong?MR. THOMSEN: No. As I said, the external environment is somewhat weaker. That’s it.QUESTIONER: Hello. Could you be more specific on the structural reforms you’re calling for? For instance, if they’re related to the liberalization of the labor market, do you think that the countries will have enough support in the population to pass this reform?MR. THOMSEN: The nature of the reforms I think are generally well understood. We published a book on it in the past year. I will refer you to that. It’s broad ranging reforms. It’s implementation of the Services Directive, product market reforms, labor market reforms, and varies from country to country. Italy, for instance, is doing labor market reforms right now that we think are very important. I understand that some of these reforms will be difficult, but I also think that by showing a determination to do these reforms, even if it’s gradual, a strong determination to do these reforms can actually have a relatively important and early impact on growth. As I mentioned, Spain is a good example of it. And, again, it’s not just a question of the political support in the affected countries, but political support inside the euro zone more generally for accommodative policies is very much linked to the willingness to do these reforms.QUESTIONER: I was wondering whether you could elaborate more on the procedure for precautionary support that Madame Lagarde mentioned yesterday so we can understand whether it’s a new agreement, an extension of the existing one under new terms, or the same terms. Is there a transitional phase that eventually leads to exit? Is it another credit line from the IMF and ESM?MR. THOMSEN: I don’t have much to add to what the Managing Director said yesterday. The good news in Greece is that it is gradually regaining market access, as we have seen. The fact is that market access still is somewhat precarious, as evident from the fairly significant increase in spreads recently. So our view is that in that situation, it’s preferable to keep some kind of relationship. As the Managing Director said, it’s an evolving relationship and discussions are getting underway. So I have nothing to say on concrete modalities at this stage.QUESTIONER: The Greek government has made clear its intention to exit the IMF program. My first question is: have you been officially notified of such an intention? And the second question is if that happened, in the following days or weeks will that affect the sixth review? Do you believe that in such case the sixth review will not be completed?MR. THOMSEN: We have not received any official notification about cancellation of the arrangement. As you know, the discussions on the review are just getting underway, and we had some technical discussions before the Annual Meetings. A review is both backward and forward looking. To complete the review one would need understandings on objectives and policies going forward and on the framework for implementing these policies. That discussion is starting.QUESTIONNER: What do you see as three main challenges for the new Slovenian government to sustain the growth momentum that was seen in Slovenia this year? Do you think that this growth is sustainable?MR. GERSON: As you pointed out, Slovenia, after a very deep recession, has now managed to turn the corner and output is beginning to grow. In terms of the three priorities for them, they need to continue cleaning up the banking sector and proceed with corporate restructuring. They need to work to continue to solidify the fiscal stance. The deficit is elevated. In addition, the debt ratio grew substantially, partly related to bank recapitalization costs. So they need to work to continue to restructure the corporate sector and the financial sector and particularly the state financial sector. They need to reduce the fiscal deficit. And the third element is to proceed with privatization. As you know, the Parliament has approved a list of 15 enterprises that are slated for privatization in the near future and we see that as important, not just to provide resources to the budget to help bring down that high debt ratio that I mentioned, but also as a way to stimulate FDI and productivity growth to establish the basis for growth going forward. So I would lay those out as the three main priorities for the new government.QUESTIONER: My question is about potential growth. I would like to know what is the target forecast for potential growth in the next years, and what are the main reasons for the slowdown this year.MR. DECRESSIN: I don't have the exact numbers for potential growth with me right now but it's clear that potential growth has been slowing, partly because actual growth is slowing, so you have unemployment moving up, people becoming detached from the labor market. It proves hard to get them back into the labor market and that means that there is less potential growth for some time. We call this the hysteresis effect and that's why it's very important that we step up the fight against unemployment in Europe. The second challenge for Europe is of course, and we emphasize this all the time, the implementation of more structural reforms to stem the decline in potential growth. In about five to ten years populations will be aging at a faster pace and so growth will be slowing even further, and that's why we are stressing the importance of structural reforms, not only to get out of the crisis but to put Europe on a stronger growth trajectory over the medium to long term.QUESTIONER: What has Spain done to be in such a bright spot right now from the last meetings? Also, now that the labor reform is completed, some international agencies are saying that maybe it's time to increase salaries. Do you agree with that? And then with a 40 percent possibility of a recession, should Spain do more to avoid going down with the rest of the euro zone?MR. THOMSEN: I will ask Phil to answer this. I said it was relatively a separate bright spot.MR. GERSON: As Poul mentioned, Spain is a relatively bright spot in Europe, and I think the authorities have done a number of things well. I would point in particular to the recapitalization of the banking system, which was extremely effective under the financial program; the labor reform has been an important step forward. The public finance authorities have made important steps to improve public finances, so I think Spain has done a lot well. The benefits of that are showing up in the restoration of growth. To your question about wage moderation, the challenge for Spain going forward is to sustain the growth that has finally come and to deal with the unemployment crisis. I use the word crisis advisedly because there was a dramatic jump in unemployment during the downturn, something close to one in five Spaniards lost his or her job during the downturn. So the challenge for Spain is to keep growth going and to keep employment recovering. That means preserving the competitive gains that they've made and continuing to ensure that as opportunities arise, firms, are able to respond to expanding business by taking on new workers. Part of the recipe therefore has to be continued wage moderation. That's not the only element of the recipe and it comes back to your question about what Spain has done well. What does Spain need to do besides that? Spain needs wage moderation but it also needs reforms to improve the business environment further, to enhance efficiency. It needs training for the unemployed to make sure that they have the skills that they need to get back in the labor force. There are changes to the tax code that could be adopted to reduce the cost of hiring low wage workers or low skilled workers. So again, wage moderation is part of the recipe, but it's not the only ingredient in the recipe. And in terms of what Spain needs to do to avoid the risks of a double dip, Spain needs to keep doing what it's been doing and it needs to take action on that set of priorities that I've just laid out. I think those are the best guarantees the Spanish authorities can have that growth will continue going forward.QUESTIONER: The ECB seems to think that credit will pick up in the euro zone once the comprehensive assessment of banks is out of the way, and with their measure that they've done recently with credit easing. Is that a view that you share? And I have another question on the same subject. If you talk to national authorities, especially national central banks, they seem to think that everything's fine with the state of health of their banking sectors; yet if you read the GFSR, it paints a much less optimistic view of the health of European banks. Could you please elaborate on this?MR. PRADHAN: On your first question, credit has been very weak, very subdued. But the most recent data suggest that the slowdown in credit is moderating. So we're at some kind of bottom here. It should start recovering. How fast it recovers from here is very difficult to tell. That's partly to do with what you pointed to in your second question, how able are banks to extend credit. But also, what we have been emphasizing is the weak demand in the euro area; credit is also very weak in those economies in the euro area that have not suffered from some of the banking system problems or financial fragmentation, so it's not only a function of the health of banks. Following the AQR, it is quite clear that given the timetable the ECB is going to follow, the banks that are short of capital will have to come up to the required level in a fairly short space of time. We're talking about six months or so, six to nine months depending on their particular results, whether it's the actual AQR or they're short of capital under the stress scenarios. We're looking at a fairly short space of time to restore banks to adequate capital levels. So in principle yes, credit conditions should improve.Secondly, the ECB's current measures of targeting credit, providing banks with a very favorable cost of finance with the TLTROs should help banks to meet the credit demand. In terms of your second question about what the national central banks say and what the GFSR says, you should wait to see what the AQR results give in terms of the specific condition of banks in the euro area, which banks are short. And of course we, like you, don't know what the results will show. But we'll wait to see what they come up with and how quickly banks can raise capital.Finally, we're just not waiting for one snapshot assessment. We have to bear in mind that over the last year or so, while the AQR process has been underway, banks have raised a very substantial amount of capital already. So it's not like they're just going to wait and see. You will have seen figures that the ECB has released, but they're also in the GFSR. We're looking at something in the region, in excess of 50 billion just in the last nine months, which we should not ignore in terms of how banks are becoming stronger as we go forward.QUESTIONER: Do you have or already received any good or bad news from the Cyprus program? For example, the results are better than expected until now? But some politicians in Cyprus say that this will not continue, that your predictions will once again prove wrong, and this time on the negative side.MR. GERSON: Developments in Cyprus so far in the program have been stronger than we had expected. Output has declined. Output is continuing to decline, but the decline is less deep than we had projected and in fact we have reduced our estimate now for the amount of the contraction this year. And fiscal performance under the program has been, again, better than we anticipated, partly reflecting the stronger macro environment. So our experience under the Cyprus program has been that things are proceeding quite well. There's still a significant amount of work that needs to be done in Cyprus, including in particular dealing with the very high level of NPLs in the banking system. But we are quite encouraged by the progress in Cyprus so far and are pleased with what's been accomplished and look forward to working with the authorities on the remaining challenges.QUESTIONER: I know you've already talked a little bit about Ukraine, but if you can give us some sense of the different potential places for the financing for Ukraine that Madame Lagarde spoke about yesterday. Are we talking about debt reprofiling? Is that needed at this point, as many economists suggest? And secondly, can you elaborate on what sort of flexibility Europe should be showing in terms of fiscal consolidation, how we should see that in light of the deficit targets?MR. THOMSEN: On Ukraine, let me give a little bit of background. You know, clearly the Ukrainian program is facing significant headwinds, but we also need to recognize that they have some good news here. We have a government that has shown a very, very strong determination to stay with the program. We do not have the early implementation problems that we had on the previous programs. And to give you an example, for instance, the fiscal targets are being met, despite the fact that the government is not collecting taxes in part of the country, and despite the fact that there is a need for higher security spending. Fiscal targets are being met and I think it speaks to the government's determination. Now, it is a situation where there is major uncertainty and we are seeing that there are capital outflows. We also see that the conflict is beginning to take a toll on the real sector on exports and on imports, spreading all the way into the balance of payments and into funding needs. So what Madame Lagarde was referring to is that we do see a somewhat higher financing need. It is too early to say how much. The mission will go out there after the election and review the program. The only message here was that Ukraine's international partners need to start thinking about how they can provide more support for the country. On the fiscal question, Jörg, do you want to answer that?MR. DECRESSIN: Europe has already made a good deal of progress with respect to fiscal adjustment. Our estimate of the structural fiscal balance for the euro area in 2013 is close to a deficit of a little over one percent of GDP, which reflects a very large adjustment that's taken place since 2010. Looking ahead to 2014 and 2015, we foresee much less structural adjustment. We think that given the economic situation in the euro area, this is broadly appropriate. As a result, some governments will meet their deficit targets. Others may miss them because growth turns out to be unexpectedly low or inflation turns out lower than expected. But we think that this should not be made up with new measures. What is in the current programs for fiscal adjustment in Europe is broadly appropriate.MR. TALLEY: Thank you and I'm sorry, Poul, would you mind commenting on the debt reprofiling need in Ukraine or not?MR. THOMSEN: Yes, that is not under discussion.QUESTIONER: Hi there. Part of this debate on growth in Europe at the moment is centering around President Juncker's 300 billion investment plan, and one of the ideas on the table is to perhaps recapitalize the EIB and certainly for the EIB to take more risk, which is drawing into question its risk profile and its rating et cetera. Did you feel that the EIB should be encouraged perhaps to increase its risk profile in order to spur growth, considering it doesn't seem to be coming from the private sector at the moment? Thank you.MR. PRADHAN: Yes, we're very supportive of efforts like building the infrastructure investment fund and encourage the public sector entities to take part in it. The EIB is already extending a substantial amount of credit per year, within the current capital that it has. So the EIB can contribute somewhat to this but at its current capital level I'm not sure that it can contribute the amounts that we're talking about.QUESTIONER: Do you think this is the right time for the country [Greece] to exit the program and look for resources in the markets? Also, are you concerned about the political turmoil right now in the country?MR. THOMSEN: I think this is more or less the same question that we had at the beginning. As I said, market access has certainly improved during 2014. But it's still a fragile situation. And in view of that, some sort of program engagement, precautionary program engagement is, in our view, advisable. On the exact modalities, as the Managing Director said, it’s an evolving relationship and those will have to be discussed.QUESTIONER: It strikes me that some of the positive things that you mention about Spain have also happened in Greece, like the recapitalization of the banks, the labor market reforms, the fiscal adjustment… and I'm wondering, what's the difference between the two countries? Is it the high debt that some at least still deem not to be sustainable?MR. THOMSEN: There's no doubt that in absolute terms, both in terms of the fiscal adjustment that's been undertaken and the financial reforms that have been undertaken, Greece has probably done more than anybody, no doubt about that. But the starting position was also, of course, so much worse. On the fiscal, Greece started with fiscal deficits that were above 15 percent of GDP and with strong deep structural problems. So Greece, unfortunately, because of its starting position, will have to do more in absolute terms.QUESTIONER: If I understood well, Mr. Decressin said that in the next coming years, for some economies, and I assume like Greece, Ireland, Portugal, you would expect not as many restrictions on the fiscal side. Would that be the case for Portugal? Do you see that as a possibility? Also, is there room for Portugal to cut taxes next year? Do you have any recommendations on that side? Thank you.MR. THOMSEN: And so the question is on taxes?QUESTIONER: Yes, and on fiscal budget.MR. THOMSEN: We think that Portugal should stick to the fiscal path that was agreed in the context of the program. As you know, there are a number of constitutional court decisions that make achievement of these targets more challenging. So I think it should be a priority to take whatever measures are needed to stick to these targets before one starts considering tax cuts.QUESTIONER: I have questions about Macedonia economy. The growth forecast is the biggest from the region of west Balkans, 3.4 percent this year and 3.6 percent next year. Why is this a good forecast and where do you see the main risks for the Macedonian economy? Thank you.MR. GERSON: As you pointed out, the forecast for Macedonia is quite strong for growth for this year and next. We believe that the authorities should see this as a window of opportunity to undertake reforms that need to be done. And I would point to two of them. One is the need to establish a fiscal anchor and to come up with a series of deficit targets consistent with that, and also consistent with rebuilding the fiscal buffers which are an essential part of the exchange rate arrangement. So part of the goal is to establish a fiscal anchor and lay out deficit targets that are appropriate.The second part of the challenge is to improve the business environment. To me, one of the things that's striking is that the authorities have set up a number of special zones that have encouraged foreign direct investment. And this has been important in bringing FDI to the country, which is useful. What we haven't seen is the spillovers from that to the domestic economy. We haven't seen the pickup in productivity elsewhere in the economy that we would have hoped for. And to me that speaks to the need to continue to make progress in improving the business environment, to increase productivity in the rest of the economy and to encourage links between the FDI that comes to these special zones and the rest of the economy, to get all of the Macedonian economy moving forward. Those are the main challenges for the government going forward.MS. GAVIRIA: Thank you Phil. We end this press conference here. Thank you all for participating.

Eurozone fears have returned with a vengeance as deepening deflation across Southern Europe and fresh turmoil in Greece set off wild moves on the European bond markets.

Yields on 10-year German Bund plummeted to an all-time low on 0.72pc on flight to safety, touching levels never seen before in any major European country in recorded history. “This is not going to stop until the European Central Bank steps up to the plate. If it does not act in the next few days, this could snowball,” said Andrew Roberts, credit chief at RBS.

Austria’s ECB governor, Ewald Nowotny, played down prospects for quantitative easing, warning that the markets had “exaggerated ideas about purchase volumes” and that no asset-backed securities (ABS) would be bought before December.

Calls for action came as James Bullard, the once hawkish head of St Louis Federal Reserve, said the Fed may have to back-track on bond tapering in the US, hinting at yet further QE to fight deflationary pressures and shore up defences against a eurozone relapse.

“The forces of monetary deflation are gathering,” said CrossBorderCapital. “Global liquidity is declining and central banks are not doing enough, either in the West or the East to offset the decline. This may not be a repeat of 2007/2008, but it is starting to look more and more like another 1997/1998 episode." This is a reference to the East Asia crisis and Russian default triggered by withdrawal of dollar liquidity.

Ominously, French, Italian, Spanish, Irish, and Portuguese yields diverged sharply from German yields in early trading today, spiking suddenly in a sign that investors are again questioning the solidity of monetary union. The risk spread between Bunds and Italian 10-year yields briefly jumped 38 basis points. This was the biggest one-day move since the last spasm of the debt crisis in 2012. This sort of price action suggests that the markets fear deflation is becoming serious enough to threaten the debt dynamics of weaker EMU states. The yields are not just discounting a protracted slump, they are also starting to price default risk yet again, or even EMU break-up risk. This is a new development that may some heartburn in Frankfurt. The markets were further rattled by an IMF warning that just 30pc of eurozone banks are in a fit state to rebuild capital and boost lending, a hint that the ECB’s stress tests could contain some nasty surprises for lenders when results are released this month. The IMF says 80pc of US banks are healthy. Greece’s yields have soared 300 basis points to 8.73pc over the last month as markets react badly to populist plans by premier Antonis Samaras to break free of the EU-IMF Troika and return to the markets for debt finance. This is compounded by fears that political deadlock will force a general election in February, opening the door for the Syriza party’s firebrand leader Alexis Tsipras. The latest polls put Syriza six points ahead of the government. The party has vowed to tear up Greece Troika "Memorandum", deeming the terms to be debt servitude. One banker with Greek ties said the local sell-off is entirely political. “The Athens stock market has tanked 24pc and residual Greek bonds have lost almost half their value. That is the clearing price for a Tsipras government. But at the end of the day the EU has too much at stake in Greece to let it fail,” he said. Professor Richard Werner from Southampton University said talk of recovery in the eurozone over recent month has been wishful thinking. “There has been a huge contraction in bank credit in southern Europe, and that means their economies are slowly imploding.” The stress in the bond markets came as data from Eurostat showed that Italy, Spain, Greece, Slovenia, and Slovakia were all in deflation in September, as were Poland, Hungary, and Bulgaria outside the eurozone. Italy’s inflation rate has collapsed to an annualized rate of minus 5pc over the last six months, once tax distortions are stripped out. Marchel Alexandrovich from Jefferies said core inflation for the eurozone as a whole has dropped to 0.53pc when adjusted for taxes, and just 0.2pc for France. The so-called "5Y/5Y" swap rate watched closely by markets as a deflation barometer crashed to a new low of 1.68pc in intra-day trading, ever further below the 2pc line etched in the sand by the ECB. “There seems to be a total capitulation in inflation expectations,” said Mr Alexandrovich. The proportion of goods in the eurozone’s price basket in deflation jumped to 31pc in September from a month earlier, according to Jefferies data. The figure was 32pc in France, 45pc in Holland, 47pc in Portugal, 52pc in Spain, 57pc in Slovenia, and 76pc in Greece. Japan’s experience in the late 1990s suggests that the danger line is around 60pc. The ECB aims to “stir” its balance sheet by €1 trillion or so over the next two years. Yet the balance has in fact contracted by €21bn over the last two weeks as “passive tightening” continues, and has dropped by roughly €85bn since the bank’s spending plans were unveiled in June. Anna Grimaldi from Intesa SanPaolo sadi the ECB will not be able to buy more than €7bn-€11bn a month of covered bonds and ABS. This is a tiny fraction of QE volumes in the US, the UK, or Japan. “We expect total purchases to amount to just under €400bn,” she said. The ECB is relying on a weaker euro as its main defence against deflation but Japan’s travails shows that this is a risky strategy without powerful action to back it up. Stephen Jen from SLJ Macro Partners said it will take very large outflows of capital to offset the eurozone’s current account surplus of €230bn, and then to push the exchange rate down to €1.20 against the dollar, the minimum level needed to kick start a recovery. “If the ECB’s actions are too weak, the euro could perversely appreciate, just as the yen did from 1990 to 2012,” he said. Prof Werner, who first coined the term QE as an adviser to Japan in the 1990s, said the ECB is making the same mistakes as the Bank of Japan at the onset of deflation. “They are following BoJ script to the letter, even repeating the same demands for structural reform. But the crisis is caused by lack of demand not lack supply. Their arguments are completely false,” he said. Richard Koo from Nomura, a specialist on Japan’s deflation, said the ECB’s cheap lending facilities for banks (TLTROs) cannot work at a time when companies and households are trying to pay down debt. “TLTROs are useless in a world of no borrowers,” he said. The error has been compounded by demands for fiscal austerity, a destructive policy in a deflationary crisis. “The ECB is at least partly responsible for the eurozone slump, giving a helpful push to the countries of the eurozone as they dropped off the fiscal cliff. If a government stops borrowing and begins saving despite zero interest rates at a time when the private sector has done the same, the economy will fall into a deflationary spiral,” he said.

Federal Reserve officials have said the latest round of soft eurozone economic data is not enough to worry them about the U.S. outlook – or revise their fairly optimistic forecasts in the months ahead.“It’s not really a surprise that growth in Europe has been underperforming for some time,” Boston Fed President Eric Rosengren said in an interview last weekend. “It may be a little bit softer, not dramatically softer. The inflation numbers have been coming in maybe a tenth or two [of a percentage point] lower than they were expecting.”That may be the case. But for Paul Mortier-Lee, economist at BNP Paribas, slipping inflation may be a more dangerous channel of contagion than weak growth – something that would still pose a problem for Fed officials, who have undershot their 2% inflation target for more than two years.

“The impact on inflation looks to be much more serious and should worry the Fed, in our view, as inflation expectations globally seem to have been fraying at the edges,” Mr. Mortimer-Lee writes in a research note to clients. “Thus, the U.S. will probably not catch Europe’s stagnation, but it could get a bad case of unwelcome disinflation.”The reason, he says, is that import prices may be having a greater effect on underlying or core U.S. inflation than they have in the past.“The evidence does suggest a stronger relationship between import prices on the core Consumer Price Index in the last two to three years,” Mr. Mortimer-Lee says.That would worry a number of Fed officials, whose preferred measure of consumer prices, the personal consumption expenditures index or PCE, has begun drifting lower again after a brief uptick.Or maybe not. Research from the Cleveland Fed in September found a much weaker relationship between import prices and the costs of consumer goods.The Fed has undertaken an aggressive response to a deep recession and soft economic recovery, keeping official interest rates near zero since December 2008 and buying over $3 trillion in government and mortgage bonds to support investment and hiring.

.Possible disinflation, a taper pause, global growth concerns —the bullish scenario for the U.S. dollar is starting to crumble. Since the start of the third quarter, the U.S. dollar index surged dramatically higher rallying 7.37% into the October 3 high. Can that be sustained? Not likely. According to a Nomura global markets research note: "Only twice since 1973 have we seen two consecutive quarters of dollar gains higher than 5% (one time from 1980 Q4 to 1981 Q2, and the other from 1984 Q2 to Q3). In fact, following previous quarters of more than 5% gains, the average return has been only 0.7% in the subsequent quarter." Part of the dollar's outsized rally move in recent weeks has been pricing in expectations of a faster Fed exit from its current historically accommodative monetary policy stance. Carrying that train of thought forward, what would be required to continue the U.S. dollar on a massive rally path? Answer: expectations of even faster and earlier than expected Fed rate hikes in 2015. In the wake of this week's unexpected comments by St. Louis Fed President James Bullard, who suggested that the central bank should consider delaying the end of the monthly bond purchases, faster rate hikes now appear less likely.What does this all mean for gold? If the U.S. dollar rally move pauses or corrects, that would provide support for the yellow metal, which is course priced in U.S. dollars. A weaker U.S. currency tends to be commodity-bullish.Let's take a look at the dollar outlook. Starting with a top down approach, let's look at a monthly chart of the U.S. dollar index, seen in Figure 1 below. Most significantly, the U.S. dollar index has not eclipsed its post-Lehman high scored in March 2009 at 89.62.

Next let's take a look at the dollar-gold correlation. Figure 2 reveals a daily chart of the U.S. dollar index, with nearby gold futures overlaid in red. An inverse correlation is seen. As the dollar goes up, gold goes down, and vice versa. Technically, the early October low in gold reveals a bullish reversal day which represents a near term bottom for gold prices.

Meanwhile, the U.S. dollar index hit overbought momentum readings in early October (bearish divergences are seen), which has opened the door to a corrective pullback in the greenback. How far could a corrective pullback take the dollar near term? A Fibonacci retracement drawn on the daily U.S. dollar chart off the rally from the July low reveals a 38.2% retracement at 84.07, a 50% retracement at the 83.24 level and a 61.8% retracement at the 82.41 level. Bottom line? The dollar rally may have run its course for now. The dollar is vulnerable to further unwinding of long positions as traders deprice the probability of a faster than expected Fed rate hikes. The dollar reached overbought levels on its recent run-up and is vulnerable to further downside correction or consolidation from a technical perspective. With all eyes focused on global growth concerns, gold is likely to benefit from dollar consolidation or weakness in the days and weeks ahead.

Copper prices clung to $3 a pound last week as encouragement over stimulus efforts by China offset worries about slowing global growth.The People’s Bank of China told financial executives last week that it plans to extend as much as 200 billion yuan ($32.8 billion) in short-term loans to 20 large banks, with the goal of spurring lending activity and boosting growth. The move comes on the heels of a cut to short-term borrowing rates for Chinese banks on Oct. 14, the second such reduction in less than a month.Investors are hoping China’s efforts will lead to greater demand for copper, as a stronger economy would boost purchases of homes and manufactured goods that use the industrial metal. Copper for December delivery, the most actively traded contract, rebounded from a six-month low to end 2.2 cents, or 0.7%, higher at $3.0035 a pound Friday on the Comex division of the New York Mercantile Exchange.Still, few market watchers expect copper’s gains to hold. “The market always wants to see China buying…[but] there isn’t a belief that this is going to turn into more industrial production,” said John Payne, senior market analyst with Daniels Trading in Chicago.As the world’s top copper consumer by volume, China has kept the market under siege throughout 2014. A slowdown in manufacturing and construction, as well as slower overall economic expansion, has led to weaker global prices for the metal.Unlike Beijing’s past stimulus efforts, which focused on large infrastructure projects such as public housing and roads, the latest measures are purely monetary and rely on the business sector to seek more credit. This might not lead to an increase in loans and business activity because sentiment about China’s economic outlook remains subdued, Mr. Payne said.China needs to grow about 8% a year to maintain commodity rallies, and it hasn’t grown at that pace in more than two years, Mr. Payne said. Chinese authorities are aiming for 7.5% growth this year.Moreover, the fact that China’s central bank stepped in to boost growth for a second month in a row is itself a signal that the economy is under stress, said Bob Haberkorn, a senior commodities broker with RJO Futures in Chicago. “The threat of unrest in China is real if the economy slows down too much,” he said.On top of the uncertainty about China, copper traders are facing the prospect of reduced metal consumption in the U.S. and Europe. Recent data showed factory-gate prices in the U.S. fell last month, while retail sales were weaker than expected. In Europe, industrial output slowed 1.8% in August from a month earlier.“The landscape for demand for copper still looks quite weak as the majority of the globe is slowing down, China included,” said James Cordier, president of Liberty Trading Group in Tampa, Fla.

But will it work?Everyone knew it was coming, but the timing still came as a surprise when news filtered through the ECB had started to buy French covered bonds as part of its promised monetary stimulus program. Covered bonds — bank bonds backed by the interest flow from pools of safe loans like mortgages — from other member states are to follow, as are purchases of asset-backed securities due to start later in the year.Because the ECB’s purchases are focused on private sector assets, rather than sovereign debt, some are calling them private quantitative easing, or QE.In theory, they ought to work as well, maybe even better, than the more conventional type of government bond purchase-based QE that the U.S. Federal Reserve and Bank of England focused on.Yet news of the ECB’s asset buying was met with near total indifference by investors. Instead, equities and sovereign debt fell back into the downward rut of recent weeks following a brief respite on Friday. Equities sold off. German bonds were bid higher, while those of peripheral eurozone economies fell back, leading to a widening yield differential between the core and the rest.The message from the markets was that investors are worried that the eurozone is heading towards recession, deflation and, possibly, another round of its existential crisis.Meanwhile, the ECB is assessing banking sector assets, the results of which are due to be announced on Oct. 26. There are worries about how much additional capital banks might be forced to raise–with central estimates of £50 billion or so for the single currency region. The greater the banks’ capital shortfall, the more constrained eurozone credit supply is likely to be, undermining the ECB’s liquidity measures, which are supposed to get banks lending.Ordinary QE is said to work by pushing down government bond yields, thus lowering interest costs across the economy while at the same time boosting asset prices (rising prices are the flip side of falling yields), designed to encourage people to spend, borrow and thus boost aggregate demand.The ECB’s measures should be more effective because they represent a more direct channel to credit creation. Some 80% of eurozone credit comes from banks. By buying assets directly from the market, the ECB encourages banks to create more of them, in other words to lend.So why might it not work?Some worry that there just aren’t enough private sector assets of the type the ECB is willing to buy to make a substantial difference to overall liquidity in the system and that because of insufficient demand and bank caution, not enough is likely to be created either.It could be that the markets already fully anticipated the impact of the ECB’s purchase program, which might explain the indifference to the actual measures. But the widening of yield differentials suggests there’s a deeper investor uneasiness.Of course, there’s one further mechanism by which QE seems to work: sentiment. The promise that a central bank will make every effort to pump liquidity into an economy and will keep going until growth takes off.Mario Draghi (pictured), the ECB president promised to “do whatever it takes” to preserve the euro in what was probably the paramount example of a central bank using sentiment to achieve end results. Except now investors feel that the ECB is constrained by politics in quite how much QE it might be able to provide. And thus that it won’t be effective.Should investors start to believe the ECB is like the emperor with no clothes, the recent unsettling market moves could become very ugly indeed.

By 2050 those aged over 65 will outnumber children under five. The first part of a series on ageing populations looks at how that demographic shift is creating a new and powerful consumer class

When Del Webb built its first retirement community in Sun City, Arizona, in 1960, the typical occupants were a retired husband and his wife who had never worked outside the home. The development promised an “active new way of life”, with a golf course, a weekly “chow night” at the recreation centre and the occasional minstrel show put on by residents.“We would never build one like that now,” says Jacque Petroulakis of Del Webb. New developments hold fewer than 1,000 units and most have space for classrooms. Many have a motorbike clubhouse, and more than a quarter of buyers are single. “The whole idea of retirement is seen in a different light today,” says Ms Petroulakis. The concept of retirement – and old age itself – is being reshaped by a record number of baby boomers who are, or are approaching, 65. The effects of this demographic shift are being felt well beyond Sun City. A recent Bank of America Merrill Lynch report cites UN estimates that the number of people worldwide aged 60 years and older will double to more than 2bn by mid-century. By 2050, the number of those aged over 65 will outnumber children aged five and under for the first time in human history. That scenario has huge implications for government, and business, not least where to find future generations of taxpaying workers. Sarah Harper, director of the Oxford Institute of Population Ageing, says “the vast majority of people in the world will make it to age 70”, once considered extraordinary old age. The shape of the classic “population pyramid” showing large numbers of young people at the bottom with a few elderly on top has changed.

Fertility rates in developed countries, and in many emerging economies such as South Korea, have fallen so far that they face a shortage of younger workers and consumers. It means the number of those who once could be counted on to buy homes, cars, motorbikes, clothing and other consumer goods is also likely to shrink in the future.

“We’ve gone from a pyramid to a skyscraper,” Professor Harper says. “It will change the 21st century in a way we never could have imagined.”

The rise in longevity has upended policy on pensions and healthcare, with governments raising retirement ages and shifting responsibility for saving and investing on to individuals.

But there is another side of the coin to the ageing population: it offers many industries an opportunity to target a whole new market.

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.